Estate Tax Planning for Hedge Fund and Private Equity Fund Managers

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With the enactment of the One Big Beautiful Bill Act (OBBBA), we now pivot to strategic, forward-looking tax planning tailored to the needs of our hedge, private equity and venture capital fund clients. Much attention has been given to income tax provisions such as enhancements to Qualified Opportunity Zones, qualified small business stock (QSBS) incentives, increased state and local tax (SALT) deductions, expanded research and development (R&D) credits and accelerated bonus depreciation.

One critical area that has received comparatively little focus is the change to the estate tax. For high-net-worth individuals, this shift presents planning opportunities that warrant attention. OBBBA creates a new $15 million “permanent” federal estate and gift tax exemption, effective for estates of decedents dying and gifts made after December 31, 2025. 

One of the primary advantages of comprehensive estate planning lies in its ability to protect assets and utilize trusts effectively. Ensuring that such plans remain adaptable to changing laws and individual circumstances, however, is essential for long-term success.

With the application of advanced planning strategies, hedge fund, venture capital and private equity managers can effectively reduce their gift, estate and generation-skipping transfer tax liabilities. These approaches also offer long-term asset protection — shielding family wealth from creditors, legal claims and divorce — while providing lasting benefits to spouses, children, grandchildren and future generations.

Backdrop

Planning with interests in private equity, venture capital and hedge funds is particularly compelling due to the ability to transfer a portion of a partner’s carried interest — often at an early stage when valuation of the fund is low and the potential for future appreciation is substantial. According to Internal Revenue Code (IRC) Section 2701, however, one cannot transfer just the carry alone. Generally, the fund manager must transfer a proportionate share of all equity interests in their fund to perfect the transfer as being a gift. This is known as transferring a “vertical slice.” IRC Section 2701 provides guidelines in determining the value of intra-family transfers of these fund interests.

Whether a general partner has an existing fund or is contemplating a new launch, valuations for carried interest can be remarkably low at this point in time. Depending on the fund’s investment strategy, holdings and risk profile, initially there is generally a high degree of uncertainty regarding the achievability of the hedge funds or private equity’s goals, capital raising and performance. This is the cornerstone of this strategy.

Importance of the Valuation

Until the fund launches and commences its trading, and with little to no committed capital from outside investors, the fund has little value from a gift tax perspective. While interest rates are higher than recent years, they are still favorable and coupled with high confidence in the markets, it is the ideal time to revisit estate planning strategies. To support this type of gifting, an independent valuation professional must assess the discounted value of the manager’s limited partnership and general partnership equity interests. In other words, an independent valuation is needed. The valuation is also needed to achieve proper gift tax disclosure.

Transfer tax optimization depends on several factors including:

• Assets under management (AUM) at the time of the valuation.
• Nature of the fund’s strategy, holdings and volatility.
• Formula which governs the earning (granting) of the carried interest.
• Whether there is any seed capital from an institutional investor.
• Investor lock-ups.
• Management and incentive fees, hurdle rates, high watermarks and withdrawal provisions.

Complicated Laws

In addition to a valuation report, an attorney that has experience in this niche area should be utilized as transfers of carried interests are subject to complex fund, estate and gift tax laws. Once the transfer takes place there are several sophisticated planning tools available to capture the interests in the funds such as family limited partnerships and a wide array of multi-generational trusts. It is also important to note that a gift tax return must be filed adequately disclosing the transaction with a qualified appraisal attached.

Dual Focus: Minimize Taxes and Protect Assets

Fund managers are uniquely positioned to leverage advanced estate planning strategies that take advantage of valuation discounts, favorable interest rates and early-stage valuations to reduce current and future estate tax exposure while enhancing asset protection. Whenever wealth transfer is contemplated, it is essential to assess the implications of the prevailing tax environment. By crystallizing your goals and objectives, analyzing your hedge fund and/or private equity fund business, coupled with proper planning and advisory, you can minimize your taxes and achieve asset protection too.

Contact Us

PKF O’Connor Davies specializes in providing income, gift, trust and estate tax planning and compliance as well as accounting and fund administration services. Our clients include a wide range of organizations and individuals, such as hedge, private equity and venture capital funds, general partnerships, management companies and their executives, family offices, entrepreneurs, private foundations and endowments.

If you have any questions, please contact your client service team or either of the following:

Alan S. Kufeld, CPA
Partner
akufeld@pkfod.com | 646.449.6319

Noam Hirschberger, CFA, CVA
Partner
nhirschberger@pkfod.com | 646.449.6363